Joint vs. Separate Revocable Living Trusts for Spouses

A revocable living trust, also known simply as a living trust, is a valuable and widely used estate planning tool. But married couples often wonder whether they should have one joint living trust or two separate trusts. The assets owned by a living trust avoid probate.

The trust structure also can make it easier for one spouse to manage property when the other one becomes unable to do so. See our December 2021 issue for more details about uses of the living trust. There are different factors to balance when deciding between separate trusts for each spouse or one joint trust.

Separate trusts can provide enhanced asset protection that can be valuable when one spouse engages in an occupation or other activities that might trigger lawsuits or potentially face creditor claims.

All the assets of a joint living trust might be subject to creditors of or judgments against one of the spouses. But when there are separate trusts, the assets in one spouse’s trust are less likely to be subject to claims against the other spouse. The details of asset protection vary from state to state.

The asset protec- tion also can vary with factors such as whether there is a prenuptial or postnuptial agreement, how and when assets were acquired and more. When asset protection is important, have a detailed discussion with an estate planning or asset protection lawyer well-versed in your state’s law. Money and asset management can be easier through one joint trust when both spouses are alive.

The spouses serve as co-trustees, and each can pay bills, make investment decisions and take other actions. With separate trusts money man- agement can be easy if the spouses are co-trustees of each trust. But if each spouse is sole trustee of his or her own trust, money and asset manage- ment might be more complicated and time-consuming, especially if one trustee-spouse becomes unable to manage a separate trust.

The biggest issue probably is what happens after one spouse passes away, and this can depend on the terms of the trust and state law. In the best case, the spouses haven’t had any other marriages or children from other relationships. They agree on how the assets are to be distributed after both have passed away, and the distribution plan is included in the terms of the trust.

The joint trust continues as a revoca- ble trust as long as one spouse is living. The surviving spouse manages the trust as though he or she owned the assets outright and makes any changes that seem wise under the circumstances. In some joint trusts, and under the laws of some states, a joint revocable trust automatically becomes irrevoca- ble after one spouse passes away. That reduces the flexibility the surviving spouse has. The surviving spouse is unable to change the terms of the trust to adapt to changing circumstances and might be limited in how the assets are to be managed.

A potential advantage of having the trust become irrevocable after the first spouse passes away is that the surviv- ing spouse can’t change who eventually inherits the property. Separate trusts might be a better solution when a spouse came into the marriage with separate assets, children from a different relationship or similar factors. When separate revocable trusts are used after a spouse passes away, his or her trust automatically becomes irrevocable. The surviving spouse cannot change who eventually receives the property or other key terms of the trust.

Unfortunately, the federal estate and income tax consequences of joint and separate living trusts are not clear. There are many unanswered questions in the tax code and an absence of IRS regulations and rulings. When there are separate living trusts after a spouse passes away, the living trust assets are included in his or her estate for federal estate tax purposes. That’s an issue that confuses many peo- ple.

While the assets in a living trust avoid probate, they are included in the estate for federal and state estate and inheritance taxes. To the extent the assets in the sepa- rate trust of the deceased spouse pass to the surviving spouse or that spouse’s trust, the deceased spouse’s estate can take an offsetting marital deduction. Also, the surviving spouse can increase the tax basis of inherited assets to the current fair market value.

The appreciation that occurred while the deceased spouse owned the assets won’t be subject to capital gains taxes. When there is a joint living trust, the tax consequences are not clear. It is likely that half the value of the living trust should be included in the estate of the deceased spouse for estate tax purposes.

The estate then receives a marital deduction because the surviv- ing spouse effectively inherits those assets as sole beneficiary of the trust. It is also likely the tax basis of half the trust assets is increased to current fair market value, because they have been inherited from the deceased spouse.

But that isn’t clear from the tax code and regulations, and not all tax professionals agree the tax basis should be increased. Some tax professionals take the ex- treme view that the trust’s entire value is included in the estate of the first spouse to die, and the trust then gets to increase the tax basis of all the assets. The results also might depend on whether the spouses live in a commu- nity property state or non-community property state.

A wealthy couple that might be subject to either federal or state death taxes might be better off with separate living trusts. The property might be split between the trusts so that neither spouse’s estate rises above the taxable level.

Or they might split the property so that only one estate is potentially subject to the taxes. But these tax issues won’t matter to most couples because they won’t be subject to federal or state estate taxes. Separate living trusts are most appropriate when couples own sepa- rate property they accumulated before the marriage or through inheritance.

That’s especially true if either spouse has children from a previous rela- tionship. Separate trusts also might be a good idea when the couple has a prenuptial or postnuptial agreement stating that certain assets and earnings are the separate property of a spouse. Setting up separate trusts might be more complicated when some assets are held jointly and title needs to be separated to fund the trusts.

Creating and maintaining two sep- arate living trusts is likely to be more expensive and complicated than a joint trust. The burden on the surviving spouse is likely to be higher after one spouse passes away when separate trusts are used. Couples who live in a community property state might find that state laws negate many of the effects of separate trusts.

A joint trust is best for most couples. It is easier to set up and transfer prop- erty, too. It is also easier to manage, es- pecially if one spouse becomes unable to help manage the assets.

Joint trusts also have a smoother transition after one spouse passes away, because often few or no actions need to be taken by the surviving spouse. A potential disadvantage of the joint living trust is that the surviving spouse can change the terms of the trust with- out restriction.

The surviving spouse could change beneficiaries, investment strategies and other trust terms. To prevent those results, some cou- ples have the joint trust automatically become an irrevocable trust after one spouse’s demise. Another option is to have a successor co-trustee added to help oversee and manage the trust after the death of one spouse.